TL;DR
This paper explains why dollar-neutral quant trading strategies, like statistical arbitrage, experienced significant losses during the COVID-19 market crash, analyzing their effectiveness, limitations, and failure modes in extreme market conditions.
Contribution
It provides a nontechnical explanation of the strategies' performance during normal and extreme market regimes, including empirical backtests illustrating their limitations during crises.
Findings
Strategies work well in normal market conditions
They tend to break during extreme events like COVID-19
Backtests demonstrate the strategies' vulnerabilities in crises
Abstract
We explain in a nontechnical fashion why dollar-neutral quant trading strategies, such as equities Statistical Arbitrage, suffered substantial losses (drawdowns) during the COVID-19 market selloff. We discuss: (i) why these strategies work during "normal" times; (ii) the market regimes when they work best; and (iii) their limitations and the reasons for why they "break" during extreme market events. An accompanying appendix (with a link to freely accessible source code) includes backtests for various strategies, which put flesh on and illustrate the discussion in the main text.
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Taxonomy
TopicsComplex Systems and Time Series Analysis · Financial Markets and Investment Strategies · Market Dynamics and Volatility